Does it really matter whether we go with an agent (a/k/a trader/broker) or a manufacturer?

Is the information in this article accurate?

Is it really that difficult to tell the difference?

Yes, yes, and yes.

The article was written by Renaud Arjoran of Quality Inspection Tips and it relates “an incredible” story Renaud heard from a friend who was searching China for a good manufacturer of LED lamps. This friend scheduled two factory visits for the same day in Shenzhen. The friend visited a factory in the morning and then visited the exact same factory in the afternoon, but the second time the name on the wall was different and the prices were 25% higher.

What had happened? One or maybe even both times, the friend was not meeting with the factory, but rather was meeting with a trader who claimed to be the factory. This goes on all the time, but is not usually so easily discovered. Renaud then discusses how to spot a trader/agent/broker:

Could he have spotted it before the visits? No. The company names were different, and one address referred to the area while the other gave a street address.

So, if you want to know whether you are dealing with a trading company or with a supplier that really owns a factory, what can you do?

As the above example shows, visiting the factory is not enough. You have to be curious and ask many questions.

Here are a few examples:

Some people who speak Chinese ask for the supplier’s name, and then they arrive by themselves (in taxi) and ask the security guard at the gate where that company is located. Guards only know the manufacturer’s name, not intermediaries.

It is also easy to ask for the name card of a factory manager, and to compare it to that of the supplier’s contact (same design? same company name?). This can actually be done by most third-party auditors if you ask for it.

A more reliable way of checking the nature of your supplier is to pay for a background check on their company. If they own no assets, they are probably a trading company. More about this topic in How to check a Chinese company’s activity.

Good advice, but back to the emailer’s questions. Why does it even matter whether your China product outsourcing deal is direct with the factory or through an agent? First off, it usually matters due to price. More importantly, however, it matters because if you deal with a trader/broker without knowing that you are not dealing directly with the factory, you do not have a contract with the factory. Why does this matter? I will give a real life example to explain.

Many years ago, a company called us after just having learned that its two million dollar order of Christmas tree lights would not be delivered to the United States until December. We called the factory and they told us they had no idea who our client even was. It turned out that our client had unknowingly been using an agent (we figured it out by looking at some Chinese language documents) and so it had absolutely no contractual relationship with the factory. So at that point, all it could do was to beg its agent to do whatever he could to get the factory to speed up the order. There was no point in suing the agent because he was one guy in a small office with an old computer (we investigated).

As we have often said, there are some excellent sourcing agents out there and those agents bring a lot to the table. A good sourcing agent will find you a good manufacturer and get you a good price. Then, and depending on the nature of the relationship and the cost, many will stay with you and make sure that the factory continually provides you with good product in a timely manner. Some will even work with you and the factory to improve aspects of your product or distribution or whatever. However, every good agent that I have seen is upfront about the fact that they are an agent and not the factory.

Is the information in this article accurate? Yes. It can be very difficult to determine whether you are dealing with an agent or the factory and I have come across countless examples (beyond just the Christmas tree light one) where the US company had no clue that it was not dealing directly with the factory.

Is it really that difficult to tell the difference? Yes and no. Yes it is if you do not speak Chinese and you are not familiar with how China does business. No, if you are able to go to the local corporate registry and simply check out the bona fides of the company with whom you are thinking of doing business.

Interesting article by Reinhardt Krause in Investor’s Business Daily entitled, “China, Companies Have A Lot At Stake Over Major Recalls” [link no longer exists], on the recent rash of product safety problems coming out of China.

The article starts out by stating that it is “mostly suppliers that knowingly cut corners to reap higher profits” who are getting the blame for “China’s credibility crisis.” But China’s climb up the value added product food chain also has caused many of its factories to struggle “to be up to snuff:”

“China is still very early in its industrial development and sins of omission are probably more likely than (purposeful) sins of commission,” said Kent Kedl, general manager of Technomic Asia, which advises companies sourcing out of China.

The article quotes David Reid, who directs the highly regarded China Clinic for CEOs at Seattle University’s business school, on China’s strong desire to protect its “brand”:

“Beijing realizes that its biggest opportunity is to develop brands, with a reputation for high quality and reliability, that have legitimacy in world markets,” Reid said. “The (product quality) backlash isn’t being taken lightly.”

The article then discusses how the real problem facing those who outsource to China is that Chinese suppliers “knowingly cut back on product quality after a few shipments have been made,” in a process called “quality fade.” It then notes that it is “very difficult to use visual inspection or testing to solve a moral gap.”

I then chime in:

While shoddy work has always been a problem in China, safety scares are a new wrinkle, says Daniel Harris, a China attorney at Harris Moure, a Seattle-based international law firm with lawyers in China.

“Everybody doing business in China knows quality issues are a problem,” he said. But it has usually been about little things, handles that break off purses.

“Now, if you’re constructing a building using Chinese steel, you’re probably wondering if you should retest it. It’s human nature to be thinking that way.”

Harris recommends that overseas buyers run credit checks on prospective suppliers. He says inspection rights should be clearly defined in contracts.

Choosing suppliers in China’s urban areas also may be a good idea, Harris says, because China’s legal system is uneven.
“There’s a lot more business litigation now in China than two years ago, and the courts are improving,” he said. “But, a court in Shanghai or Beijing is going to be a lot more sophisticated than one in some backwards outlying province.”

In case of recalls, though, U.S. companies will find it very difficult to collect damages from suppliers.

“The typical Chinese manufacturer just doesn’t have a lot of money, in part because margins are so low,” Harris said.

Chang W. Lee of the New York Times, recently wrote a very informative article on China product quality, entitled, Toymaking in China, Mattel’s Way. The article touts Mattel as a paragon of quality control in China and sets out what Mattel does to ensure the quality of its products from China.

Early on, the article nicely sets out one of the biggest issues facing every company outsourcing its product manufacturing to China (or to any other emerging market country, for that matter):

The recent wave of recalls and warnings from China has ignited worldwide concern about the safety of Chinese products, potentially mucking up a global system built, in large part, on outsourced manufacturing. As a result, companies are trying urgently to figure out how to do business here, without risking their reputation, consumer trust, or customers’ lives.

The article then puts forth Mattel as maybe “the best role model for how to operate prudently in China:”

“Mattel realized very early that they were always going to be in the crosshairs of sensitivities about child labor and product safety, and they knew they had to really play it straight,” said M. Eric Johnson, a management professor at the Tuck School of Business at Dartmouth, who has visited numerous factories in China, including some of Mattel’s. “Mattel was in China before China was cool, and they learned to do business there in a good way. They understood the importance of protecting their brand, and they invested.”

“Mattel, and many of the outside analysts, say the key is command and control.” Mattel gains this control by owning its manufacturing facilities in China, which the article describes as “a more costly method than using the lowest-bidding local manufacturer.”

Mattel still uses outside Chinese manufacturers for some of its components and for materials, but controls their quality by demanding “these outside manufacturers comply with its [Mattel’s] safety guidelines” and by analyzing and testing incoming supplies and raw materials:

That may sound elementary. But many Western companies operating in China do not test their raw materials, even though suppliers are known for substituting cheaper material to pad their profit.

“This is very common,” said Dane Chamorro, regional director of Control Risks, a global consulting company. “The samples you get are always fantastic; but once they rope you in they can cut back. And a lot of Chinese companies will do anything to cut costs.”

Providing Mattel “with fake or tainted supplies is a ticket to losing the contract with Mattel.”

Mattel initially went into China largely by using outside vendors, “but in the 1980s executives became concerned that outsourcing toy-making put trademarks at risk: the market could be flooded with imitation Barbies. Executives also thought they could handle manufacturing more efficiently themselves by building large factories:”

Mattel aggressively expanded the number of plants it owned in Asia. Noncore products, like trinkets made under movie-licensing deals, could be outsourced. But Barbie dolls and Hot Wheels, among others, would be kept in tightly controlled factories.

In 1997, in reaction to news reports of poor conditions for workers at its Asia plants, Mattel “hired S. Prakash Sethi, a professor at Baruch College, part of the City University of New York, who had an international reputation as a critic of worker mistreatment:”

Mr. Sethi would make unannounced visits to Mattel’s factories and vendors’ plants. He insisted that he would only monitor Mattel if the toy maker let him post his reports publicly and uncensored.
Mattel agreed.

Give Mattel credit for allowing the New York Times to visit “one of its Chinese factories:”

Mattel was one of only two major toy makers that agreed to allow a reporter for The New York Times to visit one of its factories in China — or even to put an executive on the phone to discuss the issue of Chinese product safety. Hasbro, LeapFrog and Zizzle — the maker of Pirates of the Caribbean toys, among others — all declined requests.

Lego does not manufacture in China, but it declined a request to visit factories elsewhere. Aside from Mattel, only MEGA Brands of Canada said it would permit a visit.

The article raises the question as to whether those who outsource their manufacturing to Chinese factories can obtain the same high level of quality control:

Some manufacturing experts say factories that are owned by global brand companies, like Mattel, often appear to be of higher quality than plants owned by vendors.

But others say that companies relying on contract factories could be just as tough if they chose to. David M. Upton, a professor at Harvard Business School, said, “You can fire the vendor, too.”

The article concludes by noting how increased quality requires increased costs, at least in the short term, but may mean increased savings in the long term:

All the toy testing and safety measures cost money. But the Mattel brand can command a premium price, said Mr. [Sean] McGowan, the analyst at Wedbush Morgan.

And, he said, “a major toy safety problem” could prove much more costly than prudence.

I really like this article because it nicely highlights by real world example some of the things companies must do to assure quality in the products they get from China. But at the same time, I find fault with much of it.

First off, the article makes it seem as though manufacturing one’s own product in China is necessarily more expensive than outsourcing this manufacturing to Chinese factories. Mattel itself says it went into direct manufacturing because it was more efficient, which implies less expensive. Beyond that, my experience with my firm’s own manufacturing clients has been that many of them have realized major cost savings by switching from outsourcing the manufacturing of their products in China to directly manufacturing such products themselves in China. Oftentimes, a portion of those savings comes from the increase in control that allows for a reduction in monitoring, without any corresponding reduction in standards.

Secondly, the article seems to imply that the reluctance of other toymakers to open up their Chinese operations to the New York Times is additional proof of Mattel’s quality prowess as compared to its competitors. I view the reluctance of these other toy manufacturers to talk as based on their desire not to publicize their China connections in today’s anti-China climate. I have been interviewed by the Christian Science Monitor, the Wall Street Journal, the Corporate Counsel and the Washington Post on the issue of China product quality and in each instance, the reporter sought my help in finding companies that would be willing to talk about what they do to ensure quality in their Chinese products. I went to my firm’s clients that do a superb job in maintaining quality control over their China products and not a single one would speak to the press, even anonymously. As one of them put it, “we have nothing to gain by talking with the press, and everything to lose.” None of the articles ended up with interviews with any manufacturers, leading me to conclude that it is not just me who has difficulty in getting companies to talk these days regarding their China manufacturing. Though I certainly credit Mattel for its willingness to talk to the media about these issues, I draw no implications regarding the quality control standards of those toy companies that chose to remain silent.

Lastly, and perhaps most importantly, like Professor Upton, I am not convinced those who outsource their product manufacturing to China cannot do pretty much the same things as Mattel to achieve pretty much the same results. Based on my own experiences with clients that manufacture in China, it is clear to me that those companies that make the effort to secure high quality product from China generally get high quality product from China and those companies that fall short in that effort typically fall short in their results as well.

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About China Law Blog

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.